General Awareness

Implications of Zero Inflation

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Implications of Zero Inflation

The recently released data on Consumer Price Index (CPI) and the Wholesale Price Index (WPI) points to a rapid decline in the rate of inflation. CPI inflation was 4.4% in November, far below the 11.2% recorded in November 2013. Food inflation is 3.1% in November 2014 down from 15.4% in November 2013. The WPI inflation rate has slumped to 0% in November, which is a five-and-a-half year low. Last year in November, it was 7.52% with food inflation at a whopping 19.52% in the same period.

The decline is clearly related to falling crude prices, which, in turn has also affected food prices. The fall in petroleum prices is the result of geopolitics of oil supply. The increased shale oil supply from the United States has forced the Vienna-based OPEC to maintain crude oil output.

The slump in oil prices will benefit net importers like India and China, which are dependent on the supply from the Gulf region. Lower oil import bill will, and it seems it has, cascading effect on food prices thereby pulling down inflationary pressure on the economy. Lower food prices will help the common man on the street and reduced spending on fuel bill could generate demand in other sectors, mostly electronics and automobile.

While the lower prices seem to give an impression that all is well in the economy, the sudden and steep fall in inflation may be a sign that deflation is setting in the economy. Deflation would be even worse as it will lead to lower profits for the corporate sector, retrenchment and low demand.

The slump in prices have increased the pressure on the Reserve Bank of India to cut down key policy rates, a long pending demand from the industry to spur growth. There is a case for lower interest rates. While it is not a panacea for triggering a higher level of growth, lower interest rates will help industrialists to undertake new projects and investments that in turn could lead to enhanced competitiveness.

But, bigger concern at present is the falling industrial growth which has shrunk by 4.4%. Manufacturing growth, whose component in the Index of Industrial Production is the highest at 75%, fell by 7.6%. The decline could be a result of twin factors – lack of new investment and slowing demand.

The trend is intriguing: while the manufacturing growth has slumped, export growth has risen in the last one month. Exports grew at 7.3% in November. At the same time, imports rose by 26.8%, particularly Gold imports, which grew by 500%. Imports of coal also went up, which is not difficult to understand due to Coal India Limited missing on its output targets.

The contraction in domestic consumer demand is likely due to the long-term inflationary pressure as well as economic insecurity, which is at work due to slower growth and lack of jobs for youth. The demand from abroad has obviously shrunk due to stagnation in the Eurozone and tepid recovery in the US.

Pushing growth in manufacturing is important and has been the core focus of Make in India campaign as well. It is manufacturing which creates jobs although IT and service industries in the economy are currently the fastest growing sector in the economy. The latter’s potential for job creation will remain low compared to manufacturing as IT and service sector requires niche skills and technical expertise.

With around 10 million people entering the job sector and mostly unskilled labour force, only manufacturing offers the hope to put them in gainful employment. India needs to push growth in manufacturing, which will lead to job creation and reduce economic vulnerabilities.

Indians spend more on gold but the current volume of spending on the Yellow metal clearly indicates that people lack confidence in the economy. Another flip side of more gold imports is widening of the trade deficit, which forced the government to put in measures to regulate it. Already the rupee is showing signs of strain vis-à-vis the dollar due to widening current account deficit. A lower rupee will help exports no doubt, but may induce volatility which is not good for attracting foreign investments.

The issue of foreign investment and keeping India an attractive destination for global investors brings to the fore hurdles to economic growth. While the incumbent regime has pushed reforms process and bills like insurance and GST, there is lack of political consensus over the trajectory and pace of reforms.

Major impediments like environmental clearance, land acquisition continue to hobble India’s growth prospects. Without reforms in these two core areas, it is unlikely rapid industrialization can take place. Reduced inflation has offered India a chance to redeem its growth rates, push rapid industrialization, job creation and improve the overall quality of life.

However, to tap these opportunities, our policymakers need to pursue right blend of policies otherwise the country stands at a road which may lead towards bigger economic recession.